Cohan: Too-High CEO Pay Caused the Crisis

Blame it all on Wall Street’s “bloated and ineffective” compensation system, writes William Cohan, an author and former Wall Street insider.

That outrageous pay caused the financial crises, he writes in an editorial in The New York Times.

Now is the time to fix it, he argues.

Bankers and traders get paid more for doing larger and riskier deals with other people’s money, Cohan says. They’re encouraged to take short-term risks with shareholders’ investments. Praise and pay are based on size, not safety.

Not surprisingly, as Wall Street devised newfangled financial products, bankers and traders sold them with abandon.

In the past, Wall Street firms were privately held partnerships, smaller and less capital-intensive, Cohan explains.

When the overall partnership did well, partners as well as non-partners got bonuses. When it didn’t, they all suffered. Collective liability kept risk-taking under control.

But the arrangement began to change when Donaldson, Lufkin & Jenrette sold shares to the public in 1969. Others, including Merrill Lynch, Morgan Stanley and Goldman Sachs, followed. Even Lazard, Cohan’s old firm, eventually went public in 2005.

“The result has been calamitous,” Cohan says. “The fallout of 25 years under this compensation system is strewn everywhere.”

The high-yield bond feast caused the crash of 1987. The proliferation of Internet public offerings prompted the dot-com bubble. Then came the WorldCom and Enron scandals.

Now it’s the subprime mortgage fiasco.

Big investment banks were designed to make as much money as possible in the short-term, James Grant, editor of Grant’s Interest Rate Observer, wrote recently in The Wall Street Journal.

To do that, of course, they took on more risk and leverage.

"Wall Street is usually described as an industry, but it shares precious few characteristics with the metal-fasteners business or the auto-parts trade," Grant said.

"The big brokerage firms are not in business so much to make a product or even to earn a competitive return for their stockholders.”

Blame it all on Wall Street’s “bloated and ineffective” compensation system, writes William Cohan, an author and former Wall Street insider. That outrageous pay caused the financial crises, he writes in an editorial in The New York Times. Now is the time to fix it, he...